A recent reader asked, why do I keep differentiating between private equity and venture capital, especially if venture capital is just a form of private equity. Well, in the strict sense, venture capital is private and it is often structured as equity, ergo, venture capital is private equity. (With that same definition, a $100 investment into a friend’s lemonade stall may also qualify as private equity.)
However, when I refer to private equity, I’m referring to a business model of investment. A few characteristics of this strategy include the following:
- The business is privately owned, not traded on a public stock exchange
- The investor is active in the strategy and management of the business
- The investor is a professional investor employing a pool of funds over a portfolio of businesses
- The investment is mostly structured as equity, which gives the investor upside exposure
- The investment is in an established business with existing customers and positive maintainable cash flows
This definition differentiates private equity from family investments at points 2, 3 and 5. It also differentiates against venture capital at point 5. The implication of this point 5 is that while venture capital is often linked to research, commercialisation and monetisation, private equity is more closely linked to expansion, succession, buyouts and recaps.
More simply, to me, VC is about building a business, whereas PE is about expanding a business. The difference may sound subtle, but it completely changes the model in terms of risk versus reward (see more here).